Unlike most other countries where investors and companies decide for themselves whether listings should proceed, virtually all the power in China resides in the hands of the regulators. And since the November 2012 debut of Zhejiang Shibao, a small auto parts maker, Chinese regulators have put the kibosh on all IPO applications.

At last count about 600 companies are in the queue, waiting to float shares. Some have been there for more than five years, dating back to before the global financial crisis.

The China Securities Regulatory Commission has said it will resume IPO approvals once it has improved listing procedures to ensure companies are properly vetted, as if the year-long halt is simply a mild technical inconvenience. Most observers think the real reason for the freeze is that regulators fear a flood of new share issues would swamp an already shaky market and so lead to a collapse in stock prices.

Whatever the exact concerns, it is a clear case of the cure being worse than the disease. The suspension of IPOs has harmed China's companies and financial system in multiple ways, and the longer the suspension continues the worse the damage will become.

The biggest victims are those companies stuck in the queue. Many are large entities with established reputations, proven business models and a need for capital to fund their expansion. They range from state-owned monoliths like China Postal Express and Logistics, which runs the country's largest delivery service with 100,000 employees, to China Grand Auto, a major car dealer backed by US private equity firm TPG.

Blocked from listing in China, some are looking to other exchanges. China Grand Auto, for example, is said to be exploring an IPO in Hong Kong. But these work-arounds are far from ideal. For a company whose main operations and ambitions are domestic, it means raising money in a foreign market and then jumping through the hoops of China's strict capital controls to channel the money where it is actually needed.

Smaller companies caught in China's IPO black hole have it even worse. These include businesses such as Yongxiang Food Processing Machinery and Neatus Traditional Chinese Medicine, which had both been vying to list on ChiNext, an exchange dedicated to high-tech start-ups.

The logic for launching ChiNext in 2009 was that high-growth companies in China were ill-served by the country's capital markets, struggling even to get loans from banks. ChiNext has had its problems – some of its early companies have been exposed as frauds and the overall board now trades at a bubbly 55 times price-to-earnings ratio.

But it has provided small companies with a significant new venue for raising funds – until IPOs were halted, that is. China has repeatedly said it wants to promote innovative industries from biotech to renewable energy and information technology to high-end manufacturing. Preventing all start-ups from tapping the stock market is certainly a curious way of going about it.

China's financial system is also suffering. Private equity firms that had eyed listings as exits for their investments are being saddled with portfolio companies for longer than planned, making it harder to reinvest their capital in new opportunities. Brokerages are smarting, too. Their revenue from underwriting fell 26.4 per cent year-on-year in the first half.

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The one group of financial companies to benefit from the moratorium on listings is the very one that China has been trying to rein in: the shadow banks. Trust firms – institutions that offer high-interest loans to borrowers hungry for cash – have seen their assets grow 70 per cent over the past year to Rmb 9.5 trillion ($1.6 trillion). In other words, blocked from raising stable equity capital, companies have plugged holes with short-term, high-cost debt financing. Anyway you slice it, the IPO blockade is an ugly development for corporate China.

Next month, China will convene a much-anticipated plenary session of the Communist party. It is a major meeting for the country's new leaders to map their plans for the coming decade. Observers wonder whether they will push ahead with difficult reforms to liberalise interest rates, open the capital account and deregulate the banking sector.

Something far simpler – ending the IPO freeze – would be an even better place to start.

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